Lenders and Servicers Beware: Court Imposes Duty Upon Lenders and Servicers To Accurately Disclose Status With Respect To Loan

In today's financial markets, creditors purchase and sell notes and mortgages frequently with the documentation of the transfers often recorded, even executed, at a later time. A recent decision by the United States Bankruptcy Court for the District of Massachusetts imposes a duty upon a lender and servicer to know and properly disclose the status of its mortgage that it holds or services, or suffer the consequences.

In Nosek v. Ameriquest Mortgage Co. (In re Nosek), 386 B.R. 374 (Bankr. D. Mass. 2008), the court entered an order to show cause why sanctions should not be imposed on the lender that originated the Chapter 13 debtor's mortgage loan, its attorneys and current holder of the loan, based on misrepresentations made by the original lender as to its status as holder of the note and mortgage.

In that case, in November 1997, the Debtor gave the lender, Ameriquest Mortgage Co. ("Ameriquest"), a note and mortgage on her principal residences to secure the note. Five days later, Ameriquest assigned the note and mortgage to Norwest Bank, Minnesota, N.A. d/b/a Wells Fargo Bank N.A. ("Wells Fargo"). The assignment of the note was recorded in 2000. The debtor filed for bankruptcy in October 2002. Two and a half years later, in March 2005, Ameriquest assigned its servicing rights to the note and mortgage to another servicer.

During the bankruptcy case, Ameriquest (i) filed a proof of claim attaching the note and mortgage and (i) signed several pleadings stating that it is the holder of the first mortgage. Ameriquest, by itself and through counsel, held itself out as the holder of the note and mortgage. It was not until an adversary proceeding was commenced against Ameriquest and two standing Chapter 13 Trustees in July 2007 that Ameriquest, in its opposition, for the first time informed the Court that it merely acted as servicer on behalf of the noteholder and that it did not hold the financial instrument.

The Court reiterated that parties who do not hold the note or mortgage and who do not service the mortgage lack standing to pursue motions for relief or other actions arising from the mortgage obligation. The Court stated that time and resources have been spent because of carelessness of those in the "residential mortgage industry and the bombast this Court and others have encountered when calling them on their shortcomings."

The Court applied an objective standard in determining whether sanctions should be imposed upon, among others, Ameriquest. Based on that standard, the court easily rejected the argument that there was no intent to mislead the Court.

The Court also rejected the argument that the assignment of the note was a matter of public record and thus the debtor knew or should have known of the real holder's identity because many of the parties asserting this position alleged that they had no way of knowing about the assignment. The Court would not bind the debtor to one standard and the creditors to a much lower one. The court stated that "it will not tolerate a lender's or servicer's disregard for the rules that govern litigation . . . It is the creditors' responsibility to keep a borrower and the Court informed as to who owns the note and mortgage and is servicing the loan, not the borrower's or the Court's responsibility to ferret out the truth."

The Court did not allow Ameriquest to use frequent trading of mortgages as an excuse for failing to know whether it held or serviced a note and mortgage. Ameriquest argued that (i) the assignment of notes and mortgages frequently occur with documentation of the transfers recorded, and even executed, at a later time; and (ii) it is not uncommon for the original note holder or mortgagee to take back the note and or mortgage when the borrower defaults. The Court rejected these excuses and placed the burden on the "sophisticated, albeit careless, lenders and servicers" to disclose their roles.

Nor could Ameriquest hide behind a Pooling and Servicing Agreement by asserting that it gave it the power to act in its own name, including filing a proof of claim. The Court noted that although it may be true for purposes of filing a proof of claim, the claim failed to attach the written power of attorney. More importantly, the court warned lenders and servicers that the "rules of this Court apply to them" and "[t]he private agreements and frenzied trading market for mortgages do not excuse compliance with the Bankruptcy Rules any more that they would justify ignoring the Bankruptcy Code." In essence, Ameriquest could not alter its obligations under Rule 9011 to accurately communicate its status in connection with the mortgage loan in bankruptcy court filings.

The Court found that Ameriquest made repeated misrepresentations and its behavior in failing to properly disclose its role was unreasonable under the circumstances. Ultimately, the Court sanctioned Ameriquest $250,000.

The Court also sanctioned Wells Fargo in the same amount. In doing so, the Court refused to let Wells Fargo hide behind the Pooling and Servicing Agreement because if Wells Fargo wished to engage servicers, it can not turn a "blind eye" to their actions. Had it shown any oversight, it should have been able to correct Ameriquest's misrepresentations. In the end, the Court would not let Wells Fargo or any other mortgagee point fingers at their servicers.

As this decision demonstrates, lenders and particularly servicers, should take all steps necessary to disclose their relationship and role in a mortgage loan transaction.